On the strategic value of risk management

This article examines how firms facing volatile input prices and holding some degree of market power in their product market link their risk management and production or pricing strategies. This issue is relevant in many industries ranging from manufacturing to energy retailing, where risk averse firms decide on their hedging strategies before their product market strategies. We find that hedging modifies the pricing and production strategies of firms. This strategic effect is channelled through the expected risk-adjusted cost, i.e., the expected marginal cost under the measure induced by investors'risk aversion, and has diametrically opposed impacts depending on the nature of product market competition: hedging toughens quantity competition while it softens price competition. Finally, committing to a hedging strategy is always a best response to non committing, and is a dominant strategy if firms compete à la Hotelling.